Sunday, January 04, 2009

What’s next for Lee?

Although its stock has been pummeled to pennies per share and its auditors have stated the company is in danger of defaulting on $1.4 billion in debt, Lee Enterprises still produces a larger operating profit, percentage-wise, than Exxon.

So, let’s not forget that there is a reasonably robust business here. The problems are that (a) the business is not as robust as it used to be and (b) the business may not be robust enough to make a $142.5 million debt payment due this spring.

Because Lee is unlikely to have the cash to pay off that loan, its auditors questioned the company’s ability to remain a “going concern” in the annual report filed on New Year’s Eve. The report sent shudders through the company and prompted a number of questions I will endeavor to answer below. But first, a bit of perspective:

While Lee is in a distinctly unpleasant position with respect to its shareholders and lenders, it is important to note that the business generated $207.2 million in operating profits last year on sales of a bit more than $1 billion. Its operating margin of 20.1% surpasses that of Exxon Mobil Corp., which generated a 19.1% margin in the last 12 months. And Lee’s profitability positively blows away Wal-Mart, the largest Fortune 500 company, whose margins were only 7.4% in the prior 12 months.

As rich as Lee’s profits are, however, they used to be richer. Its earnings before interest, taxes, depreciation and amortization (EBITDA) were 30.7% lower in 2008 than in the previous fiscal year. And that’s a big problem for a company that shouldered some $1.4 billion in debt to buy Pulitzer in 2005 in the expectation that rising sales and profits would enable it to repay the loans.

Unfortunately for Lee and several other publishers who also loaded up on more debt than they can handle, newspaper ad sales began collapsing after reaching an all-time industry high of $49.4 billion in 2005. (In 2008, sales probably were no better than $38 billion, reflecting a 23% plunge in just three years.) You can blame the collapse on major changes in the behavior of consumers and marketers, aggravated last year by the scariest economy since the Depression.

Now, Lee is in danger of having its shares dropped from the New York Stock Exchange and its auditors have warned that the company may default on its loans. Here are answers to the most frequently asked questions about these unsettling developments:

Q. If Lee had an operating profit of $207.2 million, why did it report a net loss of $888.7 million for the fiscal year ended on Sept. 28, 2008?

A. Operating profit, or EBITDA, reflects the difference between sales and the actual costs associated with operating a business. The net income calculation reduces EBITDA by such items as depreciation and amortization of assets, one-time events like plant closings or dispositions, and, in the case of Lee, a $1 billion loss associated with writing down the value of the Pulitzer acquisition. The $1 billion loss, which represents an accounting adjustment and not an actual outflow of cash, is the primary reason the company posted a $888.7 million net loss despite a $207.2 million operating profit.

Q. Why did Lee declare a loss of $1 billion on the $1.46 billion it paid to buy Pulitzer in 2005?

A. Accounting rules require a company to periodically re-evaluate the assets carried on its books. If the assets are found to be worth significantly less than their book value, the asset is deemed to be “impaired” and the company is forced to reduce the asset to its current fair-market value. The value of the Pulitzer acquisition was dropped by 68.5% for two reasons. First, the acquired properties are expected to generate lower sales and profits in the future than originally were projected. Second, the value of newspaper properties has collapsed in the time since Lee bought Pulitzer. The average value of newspaper stocks fell 83% in 2008 and Lee’s shares plunged 99% in the same 12 months.

Q. Why did Lee’s auditors question the company’s ability to continue as a going concern?

A. Given the weakness of the newspaper industry and the economy as a whole, the auditors are concerned that Lee will not be able to generate enough cash to make a $142.5 million payment due this spring on a portion of the debt it assumed when it bought Pulitzer. Failure to make the scheduled payment would trigger provisions in Lee's other borrowings that would require immediate repayment of the rest of its $1.4 billion in debt. If Lee cannot make the payment on the Pulitzer note this spring and cannot persuade its lenders to relax the terms of the other loans, then it would find itself in default on most, if not all, of its $1.4 billion in debt.

Q. What happens when a company defaults on its debt?

A. A number of things can happen, ranging from the shutdown of the business (which would be extremely unlikely in this case) to a bankruptcy filing where the company goes to court to prevent its creditors from foreclosing on the loans and seizing the assets of the business. If Lee cannot renegotiate its debt with its lenders, the company may be forced to file for Chapter 11 bankruptcy protection in substantially the same way that the Tribune Co. did in December.

Q. What happens when a company files for bankruptcy protection?

A. A Chapter 11 bankruptcy prevents lenders from seizing the assets of the business while the company reorganizes itself with an eye to emerging eventually from bankruptcy protection. This typically creates an environment where the company can negotiate better terms on its debt. A company under the supervision of a bankruptcy court will be permitted to renegotiate bills owed to vendors on everything from newsprint to rent, likely enabling unpaid trade debts to be settled for cents on the dollar. The company generally has the right to walk away from unnecessary leases on real estate, equipment and vehicles.

Q. What happens to the employees in a bankruptcy filing?

A. Wages, vacation pay, benefits and other obligations to employees usually are unaffected by a bankruptcy filing, but union contracts in some cases can be altered or abrogated. If part of the company’s reorganization plan includes reducing costs – and it usually does – then some jobs may be eliminated.

Q. How can the company avoid bankruptcy?

A. The surest way a company can avoid bankruptcy, of course, is by coming up with the cash necessary to pay its loans on time. The chief means to that end are improving sales; cutting costs to boost profitability, or selling assets like real estate, vehicles, presses or individual newspapers. In the absence of sufficient cash, a company also can urge its lenders to renegotiate its loans, which Lee is seeking to do. If the lenders are willing, the many possibilities include forgiving part of the debt, exchanging some or all of the debt for equity and extending the deadlines for repaying the loans. In almost every case, the restructuring of its debt will cost a company millions of dollars in legal and banking fees, as well as higher interest rates on its remaining debt.

Q. Lee has been warned that its shares may be removed from the NYSE. What does that mean?

A. The Big Board forbids a stock from closing at less than $1 per share for 30 consecutive sessions. Unless Lee’s shares rebound from the sub-$1 level where they have been since Dec. 1, the company is days from having its shares exiled to the Pink Sheets, an electronic trading platform for so-called penny stocks. The company said on New Year’s Eve that it will file a plan to cure the problem, but provided no details.

Q. What does it mean if Lee’s shares go off the NYSE?

A. Delisting per se is not that big of a deal. Absent an event like a loan default, business can proceed as usual for a company no longer traded on the Big Board. The resolution of the looming debt payment – whether through renegotiation, bankruptcy or otherwise – is the truly significant challenge for Lee’s management. But that is small comfort for the company’s stockholders, who watched the value of their shares sink 99% last year. The entire market capitalization of Lee was only $18.5 million on Dec. 31, 2008 vs. $677 million at the first of the year. As illustrated in the chart below, Lee’s shares have lost more than $2 billion in value since yearend 2004.

21 Comments:

Anonymous said...

The cancer that is killing Lee from the inside is its corporate culture. You forgot to mention its $770 million write-down of its "goodwill" asset last year -- an action I found amusing since the customer base of readers and advertisers of its member papers have little or no respect for the "Enterprises." In its heyday, Lee HQ allowed managers to break every business and journalism ethic in the book as long as they "made plan" for the quarter. Mary Junck no doubt thought the only way Lee would get a Pulitzer was by buying one -- and look where that got her. Now, with the cost-cutting, Lee expects its customers to keep buying a product that gets crappier every day.

You point out that Lee had a 20 percent profit margin this year, enviable in any industry. Many other newspapers are and have always been in this position. Isn't one aspect of this that's being lost in the rush to declare print dead at the feet of online that newspapers probably started to fail the day the first one went public? They were attractive to Wall Street because of those high margins, but it was unrealistic to expect them to grow, as Wall Street requires. When instead they fell, coming a bit more into line with those experienced by every other industry, the troubles began. Is a debate about the merit of public vs. private ownership (or for that matter, for-profit vs. nonprofit status) in order, or is it too late?

This of course ignores the problem of Lee's eyes being bigger than its bank account WRT to the Pulitzer purchase, something the folks worried about their jobs at the Chicago Tribune know all too much about thanks to Sam Zell.

I take issue with Anonymous' sweeping statement that Lee HQ allowed managers to break every business and journalism ethic in the book. Here's my bias: I retired last year as a Lee editor. Staffers from time to time did question the ethics of decisions made by me or the publisher. I'd glad they felt free to do so. But overall, Lee showed a commitment to journalistic ethics, and trained editors in ethical decision-making. That said, it's true there was intense pressure to make plan. And I'm worried about cost-cutting in Lee newsrooms and how that saps their ability to vigorously report the news.

Comparing Lee's operating margin to Exxon's and Wal-Mart's vividly illustrates the danger of using operating margin as a measure of value. To say there is "a reasonably robust business here" as long as they don't have to pay their debts is to say nothing useful until after the bankruptcy.

You also dismiss the billion-dollar write-off as merely "an accounting adjustment and not an actual outflow of cash."This misses the point: The outflow of cash took place at the time of the purchase, when the purchased property was booked as a $1.4 billion asset. If Lee's accountants had had an accurate crystal ball, they would have booked the loss in 2005--or 2006, or 2007.

Pretending that losses haven't happened is one of the two widespread mistake that led to the financial crisis. Taking on too much debt is the other.

Something else to keep in mind: There was a stock bubble in newspapers after the 2000-2002 crash ... knight ridder went from the 50s to the 80s when things got particularly frothy ... after dot-coms imploded, everybody wanted companies with reliable profits, which newspapers had yielded for decades.

That run-up blinded everybody to what was coming. Knight Ridder's being put on the block should've been the signal that the party was over, but nobody saw it that way at the time.

However, if you'd have been working at the San Jose Mercury News newsroom you'd have known it too well: we saw the collapse of classifieds in real time years before everybody else did, and the cuts under Knight Ridder were easily as bad if not worse as they've been under the MediaNews regime. (Interestingly, our circulation stabilized after the newsroom was cut by half. Hmmm...)

Chapter 11 sounds like something that would benefit a company in Lee's position. I have no idea what the tradeoff is, why would Lee -- or any other company in a similar situation -- want to avoid going bankrupt and the protection it offers?

The Lee paper in this city failed to express concerns about the construction of this arena. The city has taken on bond payment expenses as a result of its construction.

Journalists may claim they are "society's watchdog," but they dropped the ball on this one. At the very least, the arena should have been put in a different place. People who try to attend conventions at the site have to park in remote locations and take shuttle buses.

Because of the financial pressure, the arena once double-booked a convention and a sports event. The convention organizers had to clear the arena at one point, then set up for a second time.

Little to none of this has been covered in the paper, except when angry residents write letters.

Alan,I prepared a report on this also at http://www.chitowndailynews.org/Media_Insider/Auditors_Substantial_doubt_about_Lee_Enterprises,20777. I found the 10-K of Lee Enterprises to be a challenge, and reading your post I'm concerned that I perhaps shouldn't have accepted a report in the St. Louis Post Dispatch that the company owed $306 million in April, which led my story. That is confirmed in the 10-K on page 35: "PD LLC borrowed $306,000,000 (Pulitzer Notes) from a group of institutional lenders (the Noteholders). The aggregate principal amount of the Pulitzer Notes is payable in April 2009..."

In addition, the $306 million is sited repeatedly in the amendments to the liability contained in the 10-K as being due in April 2009. (Search for the term $306,000,000)

However, the amount you site is also clearly confirmed by the following in the annual report page 12: "2009 principal payments required under the Credit Agreement totaling $142,500,000 are expected to exceed the Company’s cash flows available for such payments... "

In addition, the notes (9) to the financial statements repeat the $142.5 million you site.

What's your take on this, is it the $306 million or the $142.5 million?

Lee indeed owes $306 million this spring but a portion of that already is in hand. The specific reason why the company's auditors questioned its ability to continue as a "going concern" is that it may come up $142.5 million short of the total sum. Since that is the reason cited by the auditors, that is the number I have used in my posts. Lee is trying to renegotiate the terms of the payment to avoid default.

In answer to questions from other readers, the term "going concern" means a business that is making more money than it loses and/or is generating sufficient cash to pay its debt on a current basis.

tgd has already pointed out the fallacy of the Exxon analogy and he is right about the "write- down". While financial analysts use EBITD to compare companies, one of the costs of doing business is the cost of borrowed money.

If I did not have to pay the interest on my mortgage or my Federal income tax, I would be much richer. And while it was finally stated in the last post "When a company goes bankrupt, the shares of its investors usually are rendered worthless." That is usually why the creditors force a company into Chapter 11 - to get total control of the company and its assets.

The two reasons the management of Lee is trying to avoid Chapter 11 is to protect what is left of their stock and options and for the founding family trust whose 6 million Class B share have 10 votes per share and allow them to control the company.

The only thing Lee can do to keep its stock from being delisted is a reverse split, say 1 new share for every 20 old shares. And to put if bluntly, DELISTING IS A BIG DEAL. Institutions and mutual funds don't buy Pink Sheet stocks. Financial analyst don't follow them either. Stockbrokers discourage their clients from buying off the sheet.

The stock market is an auction market and according to the Efficient Market Theory, at any given time all the known information about a company causes the market to place a "true " value on the stock. Anyone buying Lee at $.40 a share is just taking a chance that those 1,000 shares for $400 will be worth something some day. The easiest way to get an unbiased analyst of Lee Enterprises is to go to the reference room of a library and look up the company in the Value Line Investment Survey.

Finally, as a former Post-Dispatch employee who took a buyout, let me say that the reason I left the newspaper I respected and loved was that it became apparent the Lee had not bought the PD to raise Lee's journalistic standards. Rather it went about lowering the Post to Lee's standard.

Sending some of their small-town ad salesmen to St. Louis to go on calls with the Post employees became a sad joke that we all laughed at. No, our ad salesmen did not go and sit in the small town dinner and see all their clients or bake cookies for them or meet them at the Rotary Club.

Finally, in one last act of desperation, Lee is trying to get the people of St. Louis to pay a $20 yearly subscription for the weekly Journal Newspaper, a shopper that is now thrown on every lawn for free!

To follow up on Lou Grant's question, Lee has two different debts it is juggling. The $306m balloon payment is a debt is acquired from Pulitzer. The Credit Line is a separate debt it incurred to finance the purchase of Pulitzer in 2005. Under its deal last year with its creditors, Lee was forced to direct all available cash flows to repayment of the Credit Line. So my reading on this is it has $142m for the Credit Line but nothing left over for repayment of the Pulitzer Notes. It should also be noted that the Pulitzer Notes bear 8 percent interest, so the balloon payment covers only the principal on the loan. At 8 percent a year, the total debt is more than $600m.

I agree with tgd that saying Lee has a robust business while ignoring its debts is a meaningless statement. Lee's cash flows have been shrinking since the Pulitzer acquisition not growing, which is how we got to where we are today. The whole model for the acquisition was flawed.

As a journalist for nearly 20 years, i've lost faith in the newspaper industry in general, which in my personal opinion began to decay back in the early 90s when chasing the almighty buck seemded to become more important than providing hard-hitting, watch-dog-type news coverage; maybe yet another victim of big corporate ownership. maybe the public would be better served if newspapers became not-for-profit.

The rot started in the 70's when Gannett bought out the Des Moines Register and other great family-owned houses. Then pipsqueaks like Lee moved in later to bottom feed and further the process. Dance on their bones and figure out a new way to post your community's thoughts. When "entreprenaurs" like Lee, Gannett and Murdoch move in, it's over for the pure information that citizens need. Separate news from "entertainment" again and separate pundit-ganda from everything. Semper FI Who What Where When & Why!

I was a Howard employee when Lee purchased our group of papers. In the beginning, I thought that the corporate backing we would receive from Lee would be a welcome addition to our product. As time moved forward it quickly became apparent that the management staff at Lee was completely unprepared to lead. Say want you will about the demise of journalistic standards - I agree - however, I was an Ad/Internet Sales executive who was subject to unrealistic and quite frankly foolish expectations. Needless to say, many good people began to leave the company at a time when Lee needed good people to guide them through these hard times. Then, purchasing the Pulitzer chain was simply irresponsible. My position allowed me access with Mary and her upper management quite a few times. I have always found her a likable, engaging person. Problem is that her surrounding staff was too wrapped up in their own ego(s)/wallets, lacked direction, and showed little respect for the employees(and yse I have many first hand stories). Honestly, it is the same philosophy that allowed companies like Monster and Autotrader to eat newspaper's lunch. Too wrapped up in themselves and their profits this month to care... no vision. Now, no vision and a lot of debt. On other item, I take a little offense to the gentleman that thought ad reps from other smaller newspapers sent to St. Louis was laughable. I was one of the reps they asked to help in St. Louis online sale blitz. I rejected the assignment, not because I was from a smaller newspaper(for the record, I'm from a large metropolitan city but choose to work at a smaller newspaper) and that I thought the sales technique was apple and oranges, but because of the philosophy behind these sale blitzes. What the St. Louis staff needed was training -in particular online training - not a hand out. The blitzes are a band aid and not a fix, and that attitude that only big city folks understand the big city is just another branch of a old school management tree that is just about ready to fall. The right people, regardless of where they came from, under the right structure and plan, can make a difference.

About Me

Alan D. Mutter is perhaps the only CEO in Silicon Valley who knows how to set type one letter at a time.
Mutter began his career as a newspaper columnist and editor at the Chicago Daily News and later rose to City Editor of the Chicago Sun-Times. In 1984, he became No. 2 editor of the San Francisco Chronicle.
He left the newspaper business in 1988 to join InterMedia Partners, a start-up that became one of the largest cable-TV companies in the U.S.
Mutter was the COO of InterMedia when he moved to Silicon Valley in 1996 to join the first of the three start-up companies he led as CEO.
The companies he headed were a pioneering Internet service provider and two enterprise-software companies.
Mutter now is a consultant specializing in corporate initiatives and new media ventures involving journalism and technology. He ordinarily does not write about clients or subjects that will affect their interests. In the rare event he does, this will be fully disclosed.
Mutter also is on the adjunct faculty of the Graduate School of Journalism at the University of California at Berkeley.